Is McLeod Russel India (NSE:MCLEODRUSS) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, McLeod Russel India Limited (NSE:MCLEODRUSS) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for McLeod Russel India

How Much Debt Does McLeod Russel India Carry?

The image below, which you can click on for greater detail, shows that McLeod Russel India had debt of ₹21.1b at the end of September 2020, a reduction from ₹22.9b over a year. However, because it has a cash reserve of ₹1.20b, its net debt is less, at about ₹19.9b.

A Look At McLeod Russel India's Liabilities

Zooming in on the latest balance sheet data, we can see that McLeod Russel India had liabilities of ₹29.6b due within 12 months and liabilities of ₹3.40b due beyond that. Offsetting this, it had ₹1.20b in cash and ₹2.06b in receivables that were due within 12 months. So it has liabilities totalling ₹29.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹2.27b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, McLeod Russel India would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

McLeod Russel India shareholders face the double whammy of a high net debt to EBITDA ratio (12.7), and fairly weak interest coverage, since EBIT is just 0.34 times the interest expense. The debt burden here is substantial. One redeeming factor for McLeod Russel India is that it turned last year's EBIT loss into a gain of ₹655m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since McLeod Russel India will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, McLeod Russel India saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, McLeod Russel India's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Considering all the factors previously mentioned, we think that McLeod Russel India really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for McLeod Russel India you should be aware of, and 1 of them is a bit unpleasant.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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